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USC ECON 205 - Capital, Risks, Reward, and Change over Time

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ECON 205 2nd Edition Lecture 9Outline of Last Lecture I. The business cycle revisitedII. Macroeconomic EquilibriumIII. Multiplier ModelIV. Change in investmentV. MonopoliesOutline of Current LectureI. Capital and assetsII. Effect of interest rate and rate of returnIII. Time and RisksIV. ProfitCurrent LectureI. Capital and assetsCapital goods are tangible and intangible durable products that are used for further production,such as machinery, buildings, and manufacturing equipment. Capital can be both inputs and outputs. Structures that are capital include factories and homes, equipment, machinery, and automobiles. Inventories, another form of capital, include cars in dealer lots and unsold products. Lastly, intangible capitals are software, patents, brands, and the like.Capital is bought and sold in capital market. Rentals are payments for temporary usage of durable capital or land.II. Effects of interest rate and rate of returnFinancial assets are monetary claims. They increase productivity of other factors, and are thingslike student loans, mortgages, and savings into investment. These create values ex nihilo, drivingthe economy.The interest rate is the rate of return on fixed interest and financial assets. Return on investmentis the price of borrowing or lending money. The rate of return depends on the asset’s maturity, the risk involved, the cost, taxes, and credit.- Present value is the value of assets at the current time.ROI is the rate of return on investment. Determines allocation of capital into alternative investments.- Rate of return on capital has not fallen due to technological innovation. The demand for capital slopes downward due to law of diminishing returns for capital. When interest rate rises, bond and stock prices fall. Asset prices move inversely with interest.III. Time and RisksTime has an effect on yield rate. Long-term securities have higher interest than short-term ones.The risk involved is the chance that the security, bond, or loan will default or the company involved will become insolvent or bankrupt. United States Treasury bonds are backed by the full faith, credit, and taxing power of the United States’ federal government and strengthened by the government’s long history of honoring payments.IV. ProfitRevenues minus costs equal profits. Profits are also defined as residuals left over from operatingcosts (wages, maintenance, and other expenses). Subtract market value of owner’s wages, rental values, and owner’s interest in capital.Economic profit, however, is equal to revenues minus all costs—including implicit costs or opportunity costs.Finally, profit is also defined as the reward for

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